Friday, May 22, 2009

U.S. Treasury Yield Spike-Inflation Or Default Fear?

The U.S. dollar has in recent days depreciated significantly in value against most currencies, while yields on Treasury securities have spiked. The 10 year yield has increased to 3.45%, up from the December 18 2008 low of 2.08%. This has been attributed in the financial media to increased worries about the United States federal government losing its top AAA rating from rating agencies like Standard & Poor's and Moody's. Given the dismal track record of these rating agencies, I see no reason to care about that, but since some other people might care, it can't be ruled out that this could be a factor.

However, it seems that market fears are less about any potential formal default, than it is about increased fear of inflation. While the TIPS-nominal Treasury yield spread is not a perfect indicator of inflation expectations, it still gives you a fairly good picture of changes in inflation expectations most of the times.

In Monday, the nominal 10-year yield was 3.22%, while the 10-year TIPS yield was 1.66%, meaning that the spread was 156 basis points. Since then, the TIPS yield has barely budged, rising to just 1.67% when this is written (since yields constantly change in the markets, it might be slightly different when you read it), but the nominal yield has increased some 23 basis points to 3.45%, meaning that the spread has increased 22 basis points to 1.78%, the by far highest level in 2009.

The fact that the price of gold is again rising also confirms that inflationary expectations are rising.

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